India’s FSP Resolution Gap: Beyond SMC/IBC Overlap

A persistent debate continues to animate discussions surrounding India’s impending Securities Markets Code (SMC), 2025, particularly its perceived clash with the established Insolvency and Bankruptcy Code (IBC), 2016. Concerns frequently surface that the SMC’s provisions, which safeguard settlement finality, close-out netting, and collateral enforcement, might directly conflict with the IBC’s moratorium, waterfall, and estate provisions. However, a deeper analytical dive reveals these fears of direct overlap are largely misplaced. Instead, the apparent tension illuminates a more profound structural vulnerability within India’s financial legal framework: the critical absence of a dedicated, specialized resolution mechanism for financial service providers (FSPs) whose failure could trigger widespread systemic repercussions.

The Fundamental Distinction in Regulatory Purpose

To properly frame this discussion, one must return to first principles regarding the core objectives of each legislative instrument. The SMC, by design, aims to ensure the smooth, uninterrupted functioning of the securities market, even when a participant faces severe financial stress. Its primary goal is to prevent contagion and maintain market stability. In stark contrast, the IBC is fundamentally structured to provide an orderly process for resolving financial distress, typically for commercial enterprises, with the goal of maximizing asset value for all creditors through a structured insolvency estate.

This inherent difference in purpose immediately suggests a complementary, rather than conflicting, relationship. The SMC focuses on the continuity of market operations, while the IBC addresses the orderly cessation or restructuring of a defaulting entity. The mechanisms within the SMC — settlement finality, close-out netting, and collateral enforcement — are not arbitrary additions; they are foundational pillars designed to mitigate systemic risk by ensuring that transactions, once initiated, are completed, and that counterparty exposures are contained and secured. Without these, a single default could cascade, leading to a freezing of market activity.

IBC’s Explicit Recognition of Third-Party Assets

A central pillar of the argument against a direct conflict lies in the nature of assets held by key market intermediaries such as clearing corporations (CCs) and clearing members (CMs). Assets like margins, collateral, and securities under their management are typically held in a custodial, fiduciary, or contractual capacity. Crucially, these are not considered their proprietary assets. The IBC itself acknowledges this fundamental distinction, explicitly stipulating that such third-party assets do not form part of the insolvency estate of the defaulting entity.

Furthermore, the IBC contains specific provisions addressing the treatment of collateral, set-off arrangements, and multilateral netting. This means that safeguards provided by the SMC largely pertain to assets and obligations that are already either excluded from the insolvency estate or subject to specific, distinct treatment under existing insolvency law. Thus, the SMC’s protections serve to reinforce these existing principles within the financial market context, ensuring that the unique characteristics of securities transactions are preserved. This framework demonstrates that the two codes are not attempting to govern the same assets or processes in contradictory ways, but rather, the IBC provides a general framework that the SMC then refines for the specific, highly interconnected domain of securities markets.

The Unaddressed Structural Gap: FSP Resolution

While fears of direct overlap may be unfounded, the debate inadvertently highlights a more critical and unaddressed issue: the glaring absence of a clear, dedicated resolution mechanism for a failing CC or CM. These entities are not typical commercial enterprises; they are systemically important financial institutions that handle vast sums of client money, facilitate complex market transactions, and are deeply interconnected within the financial ecosystem. Their failure carries far greater systemic risk than the insolvency of a manufacturing company.

The SMC anticipates such failures, addressing the consequences of insolvency, liquidation, and resolution proceedings by protecting settlement finality and collateral enforcement. However, it does not, by itself, offer a comprehensive resolution framework. FSPs are generally excluded from the standard scope of the IBC, which is ill-suited for their unique operational and asset structures. This creates a dangerous void: if a major CC or CM were to fail, the existing legal toolkit is inadequate to manage the crisis swiftly and effectively without triggering wider market instability.

Interim Solutions and the Path Forward

In the interim, Section 227 of the IBC offers a potential, albeit temporary, pathway. This provision empowers the Central Government, in consultation with relevant regulators, to extend the insolvency framework to specific categories of FSPs, with necessary modifications. When read alongside the SMC, this suggests a pragmatic, short-term approach: the IBC could provide the procedural structure for resolution, while the SMC would guide the specific modifications needed to uphold market functions, settlement finality, netting, and collateral protection during such a process. This adaptation could serve as a stop-gap measure, preventing a complete regulatory vacuum.

However, this adaptation is not a substitute for a purpose-built solution. What most people get wrong in this debate is focusing on the perceived, rather than the actual, problem. The focus on “overlap” distracts from the more fundamental structural challenge of managing the failure of a systemically important financial intermediary. A dedicated resolution regime for FSPs would incorporate the speed, specialized expertise, and preventative powers necessary to manage such complex failures. It would acknowledge their unique role in handling client assets and facilitating market transactions, ensuring stability rather than merely managing a liquidation.

One Thing To Consider Today

When evaluating new financial legislation or perceived regulatory conflicts, it is imperative to analyze not just the textual provisions, but the underlying structural purpose and the distinct nature of the entities and assets involved. The current debate around India’s SMC and IBC is not merely about legal definitions; it is an opportunity to reinforce the foundational resilience of India’s financial architecture by addressing the long-standing need for a robust, dedicated framework for FSP resolution, moving beyond reactive adaptations towards proactive structural stability.